Estate & Gift Tax
Bogdanski
Fall 2014

Sample Answers to Question 3

Exam No. 9856

Discussed by Transaction:

Greenacre

The purchase of the office building as joint tenants with rights of survivorship (JTWRS) constitutes a present gift of $100K by Sofia to Barry. A gift occurs when buying a property in JTRWS to the extent that no consideration is received for that interest -in this case Barry is only less than half for a half-interest in the property. The difference of what he paid relative to what he received is a gift -in this case he pad $100K less than he should have. It is eligible for the $14K annual exclusion as a present interest since it is an outright gift of property (not in trust). This analysis assumes that the state in which Greenacre was purchased allows for severability of JTWRS by either of the tenants into a partition of tenancy in common. Barry and Sofia are not married, so no community property or marital deduction issues are at play (and no GST tax is at issue since they are of the same generation). Sofia can elect to use as much of her unified credit as she wants towards the gift, possibly resulting in no tax owed.

Irrevocable Trust

The transfer of $7.5 million to the trust is a completed gift by Sofia since it is irrevocable and Sofia retains no power to change its disposition. The trust provides only a special power of appointment to the trustee, Casey, and therefore will not cause potential gift tax consequences to Casey upon her failure to exercise the powers. It is a special power and not a general power because it can only be exercised by Casey to benefit Sofia's mother -not Casey, or her estate or creditors. Thus she is a mere conduit and does not have to worry about being seen as the owner of the property. However, the special power of appointment does cause the trust to fail to have any "present interests" for the purpose of the annual gift tax exclusion. Barry, although having a general right to income from the property, does not have a present income interest because his right to income can be defeated at the COMPLETE discretion of Casey (there is also a question of whether the property actually produces income, since it is a transfer in trust). Furthermore, Mai also does not have a present income interest because her ability to get income (or corpus) is not governed through an ascertainable standard (or other enforceable legal right), but rather the COMPLETE discretion of Casey. Thus although there are possibly two beneficiaries that could receive income in any given year, their present interest is too contingent to qualify for the annual exclusion.

There is no GST because all of the beneficiaries are either older or in the same generation.

Year End Gifts to Daughters

Each gift will be eligible for a $14K annual exclusion as a present interest since it is made outright to each recipient (Iris and Jessica). Thus there would be gift tax on $12K of the amount given (($20K x 2) - ($14K x 2). Sofia is not married so she can't elect to split the gifts, but she can apply any unused unified credit she as to it (assuming she didn't use it all up on the trust transfer). The gift would not be considered complete until the daughters have actually cashed them (such that Sofia could not revoke the gifts -she has too much control over the property until that moment). This raises a concern with the timing of the gifts and the fact that Sofia seems to do it each year at the same date. Even though the gifts are MAILED on December 20, they might not be completed until either that calendar year or the next (the mailbox exception only applies to charitable gifts). Since the annual exclusion only applies once per year (hence "annual exclusion"), this could have the unsavory effect of a gift being double counted in one year and not counted at all in another. For example, if Iris and Jessica both cashed their 12/20/2011 checks in 2012, and also cashed their 12/20/2012 checks on 12/30/2012, Sofia would have an additional $40K of taxable gift in 2012.

There is no GST impact on these gifts since they are only one generation removed.

Sofia's Death

The exact estate tax consequences of Sofia's death depend on how long ago the earlier transactions took place (no dates are given in the question). If any of the above gifts took place within 3 years of the death any gift tax paid would be brought back into the estate via § 2035. Sofia does not appear to have retained any interests in the trust (it does not state whether she could remove the trustee and place herself as one, for the purposes of this analysis, where only the special power of the trustee was terminated, I will assume that she cannot) -thus the trust appears to avoid inclusion through §§ 2036 - 2038. Because of this the $8 million dollar trust has effectively been taken out of Sofia's gross estate upon her death.

Greenacre, as community property, is included in Sofia's estate, though not at the full $1.5 Million. The amount included would be determined by multiplying the FMV of the property (1.5 million) by the survivor's consideration paid ($400k) over the entire consideration paid (1 million). In other words, Sofia would only include 1.5 million x .4.

The $5 million in assets transferred to Sofia's mother would also be taxed at the top rate of 40% assuming that Sofia has no unused unified credit remaining (which would depend on her earlier elections). There is insufficient information on the nature of the assets to determine if any valuation discount would apply. No GST would apply because Mai is older than the Sophia. The same would apply to the $2 million going to Barry.

Sophia would not have to pay any estate tax on the money that was in her estate but used to pay (1) the state death taxes, or (2) the income tax owed for Sofia's final taxable year. Both taxes are considered valid "claims against the estate" under §2053. The facts seem to show that these are income taxes on all the income earned and reported on Sophia's last tax return -not income received after her death and reported on fiduciary returns thereafter. Generally these deductions are allowed when actually paid, which appears to have been promptly. Depending on the size of these tax obligations and whether they might be reduced by later IRS action (i.e. an overpayment of income or state tax), Sofia's estate may have to file an amended return with a smaller deduction since event occurring after the death of the decedent can alter the amount allowable.

Lastly, it does not appear beneficial to use the alternate valuation date since none of Sophia's property appears to be depreciating/there is no mentioned market crash. GST is not implicated in the administration of her estate because none of the legatees are more than one generation removed from Sophia.

Exam No. 9008

Tax consequences of joint tenancy in Greenacre

Under § 2040(a), the entire value of Greenacre is included in Sofia's gross estate, except for the portion that is excluded because of the consideration that Barry provided for his interest. Under § 2040, the value of Greenacre that is excluded from Sofia's estate is proportionate to the consideration the Barry, the surviving tenant, furnished for his interest in the property. Assuming that the $400,000 paid by Barry was his own money, and not given to him by Sofia at some point prior to their purchase of Greenacre, Barry has provided two-fifths ($400,000/$1 million) of the purchase price for Greenacre, and so Sofia's estate may exclude from the gross estate two-fifths of the value of Greenacre on the date of Sofia's death. The value of Greenacre that is included in Sofia's gross estate is therefore three-fifths of $1.5 million, or $900,000.

On the date of the purchase, Sofia has made a taxable gift of $100,000, minus the $14,000 annual exclusion (assuming no other gift from Sofia to Barry that year), to Barry because Barry receives a one-half interest in Greenacre, worth $500,000, but pays only $400,000 in consideration for the interest.

The irrevocable trust

There are no transfer tax consequences to Casey for receiving or relinquishing the power of appointment over the trust property because Casey does not hold a general power of appointment under § 2041. Casey can only appoint trust property to Sofia's mother, Mai, and cannot appoint property to herself, her creditors, her estate, or the creditors of her estate.

The power of appointment given to Casey is relevant if Sofia had the right to remove Casey and appoint herself as trustee, assuming that the power to appoint to Mai is a power of the trustee and not a power that can only be held by Casey. Depending on the timing of the termination of the appointment power, the value of the trust may be included in Sofia's gross estate under §§ 2036, 2038 and 2035. If Sofia had the power to remove Casey and replace her as trustee, then Sofia is considered to have the power to alter or terminate the trust under § 2038, or the power to designate the recipient of the income under § 2036(a)(2) because Sofia could replace Casey as trustee and appoint all of the corpus to Mai. This power would require inclusion of the trust corpus in Sofia's gross estate if she died before the trustee's power of appointment was terminated, and if Sofia died within three years after the termination of the power, § 2035 would apply to bring the trust property back into Sofia's gross estate, including the amount of gift tax paid by Sofia on this transfer.

Assuming that Sofia hasn't retained a power to appoint herself as trustee as discussed above, Sofia has not retained any strings on the property in trust, because she has not retained any interest for herself or retained a power to revoke or amend the trust. She has made a completed gift, for which she will pay gift tax on the value of the trust that exceeds the amount excluded by the unified credit. Sofia has already used some of her unified credit in making the gift to Barry of part of his joint interest in Greenacre, but the remaining credit can be used on the transfer to the trust.

Gifts to Iris and Jessica

The gifts to Iris and Jessica are gifts of a present interest and are eligible for the annual exclusion. Sofia is only taxed on the $6,000 she gives to each of her nieces. There are two timing issues: first, if Sofia died before Iris or Jessica cashed their checks, the amount of the check(s) would not be lifetime gifts eligible for the annual exclusion and would be included in Sofia's gross estate under § 2033. Second, the annual exclusion will apply in the year in which Iris and Jessica cash their checks, so if they wait until January to cash their checks, Sofia won't be able to make further annual exclusion gifts to them in the following year. There are no GST tax concerns to this gift because Iris and Jessica are not skip persons, they are only one generation below Sofia.

Sofia's estate

Sofia's gross estate includes a portion of the value of Greenacre, as discussed above, under § 2040. Her estate also includes the fair market value of the $5 million in assets that she leaves to Mai, and the $2 million in assets left to Barry. Sofia has already used her unified credit in making the lifetime transfer of $7.5 million in trust, so her estate will pay estate tax on the entire value of these assets.

Sofia's estate can take deductions from her gross estate in the amount of the income taxes that the estate paid for Sofia's last taxable year under § 2053, and for the state death taxes paid under § 2058. Barry may be entitled to reimbursement under § 2205 because the taxes were paid from his share of the estate, except that Sofia's will provided for the taxes to be paid from Barry's share.

Exam No. 9651

There is no GST tax.

Greenacre

When Sofia (S) purchases Greenacre, this is a completed gift Barry (B) for the difference of the FMV of her interest and 1/2 the cost of the property or $100,000. S can use her annual exclusion because B's has a present interest right to the property. S can use her remaining lifetime exclusion on the rest of the $86,000. S's interest in the property will be included in her gross estate. S is not an Oregonian because JTWROS are not legal in Oregon which is too bad because she is so "green."

Irrevocable Trust

This is a completed gift to B. Because B has an income interest and a remainder interest, W will be taxed on the entire value of the trust. Casey has the nongeneral power to appoint the corpus of the trust to Mai (M). The creation of a nongeneral power to appoint is not a gift and the exercise of the power is usually not a taxable event (therefore the lapse of the power is not a taxable event). Unless the nongeneral power to appoint creates a new power, discharges a legal obligation or it releases an interest then it is not taxable. Casey is not limited by an ascertainable standard. Because Casey has a nongeneral PoA, there are no tax consequences for the interest M has in the trust. When the power terminates, this is not a taxable event because the power is a nongeneral power of appointment. Depending on the assets, the value of the trust may be entitled to some discounts. W may not use her annual exclusion for this gift because it is not a present interest, B has no right to the corpus presently and although he has present right to income there may not be any income so it is only a future interest. W can use her lifetime annual exclusion.

Annual Gifts

S's gifts of 20,000 will be taxed on the value that is above the annual exclusion of $14,000. So combined, S will have to pay gift tax on $12,000. In general, checks are completed when deposited in the bank account for gift tax purposes. S puts these gifts in the mail on Dec. 20 and in the next paragraph it says she dies (but gives no date). If S dies before the check are delivered then the gifts are not complete. If S dies after the checks are deposited then they are completed.

Sofia's Estate

The full value of her joint tenancy will be included in her estate less the proportional amount paid by other joint tenants (2040(a) first proviso). The applicable ratio is the consideration paid by S divided by the total consideration multiplied the FMV at her death. So 60% of 1,500,000 or 900,000. Depending on when S dies will determine whether the trust will be included in her gross estate. If she dies three years after the trust is set up then it will not be included in her estate because she did not retain any power over it. If she died within three years of creating the trust, then the full value of the trust will be included in her estate. So S could either have 8,000,000 or nothing in her estate depending on how long she lived after the trust was created. Of course the value of the trust will have the same discounts available as the discounts it took at the time of the gift. The 5,000,000 of assets she bequeathed to M will be included in S's estate. S's IRD will be included in her gross estate but her estate will get an income tax deduction for the estate tax that was paid on it. Also, S's estate will get a deduction for state tax paid under 2058. So S's estate will have at least 7,900,000 to be taxed on or 15,900,000 if the entire trust is included in her estate. Under 2032, S's estate can choose to value the estate at the date of death or 6 months after his DOD. This may be a good option for S. Under 2032, if the estate elects to use it, the entire estate will be valued 6 months after the death of the decedent, instead of the DOD. Note that this would not apply to any property which depreciates merely due to the passage of time but there is no indication of such property in S's estate. The election is all or nothing and the estate must elect to value everything, not just certain assets. This election must lower both the gross estate and the estate tax (no basis games). Whatever lifetime credit that S has not used up during her lifetime she can use.